International | Jun 26 2006
By Chris Shaw
With the US Federal Reserve poised to lift interest rates again this week the game now is readjusting expectations to the fact rates are likely to move higher than had been anticipated even just a few weeks ago.
In the view of ABN Amro’s Tim Drayson a similar situation is likely to play out in the Japanese market, as the current political pressure to delay increases in official rates could see rates eventually moving higher than the market expects.
Drayson suggests the economy should continue to grow at above trend rates, thanks to both the weak yen boosting exports and a recovery in domestic demand thanks to higher wages and consumer spending. This is where the outlook differs from Europe, as the employment market in Japan is currently very strong and wages are increasing. In contrast the European experience is of little wage growth, which is holding back the emergence of stronger consumer demand.
He expects next week’s Tankan survey results, which measure the level of business confidence in the economic outlook, to support his view of a strong economy, but cautions an overheating remains possible while the economy continues to operate at or near full capacity in an attempt to finally bury the problem of deflation.
While this is positive for the growth rate it means real interest rates have turned negative, a situation he expects will continue through the rest of this year. Partly this reflects political pressure on the Bank of Japan to delay any hikes given a new Prime Minister will be chosen in September. But as Drayson notes it also means the bank is behind the curve in lifting rates, which increases the chances of additional rate hikes in the future as the bank tries to play catch up to keep inflation under control.
Such a view is shared by Bank of Japan policy maker Kiyohiko Nishimura, who suggested the maintaining of excessively low interest rates could lead to overinvestment by the corporate sector, which in turn could prove too stimulatory for the economy overall. Drayson continues to forecast a rate increase in July, though he expects it to be modest and to be followed by a further increase later in the year.
Looking further out, Drayson suggests investors should remain aware rates may move higher in Japan than is currently anticipated, his forecast of 2% for official rates by the end of 2007 being well above some estimates in the market. In his view, such an environment is more conducive to outperformance in equities than in bonds.
